In a major change in the law, the Court of Appeals for the Federal Circuit (”CAFC”) held in Transcore v. ETC found that covenants not to sue have the same effect on patent exhaustion as a patent license (i.e. a sale permitted under the covenant not to sue would “exhaust” the patent) http://www.cafc.uscourts.gov/opinions/08-1430.pdf.  

Consequently, a first sale that falls within the scope of a patentee’s covenant not to sue is considered “authorized” and exhausts the patent with respect to downstream customers and users. This holding is dramatically different from the assumptions of most lawyers.  In fact, lawyers frequently use a convenant not to sue rather than a patent license to avoid patent exhaustion. 

This issue is very important for software licensors, both commercial and open source,  because they must now rethink their approach to patent licensing.  For example,  Red Hat used covenants not to sue in its Firestar settlement to cover certain parts of its ecosystem http://www.redhat.com/f/pdf/blog/patent_settlement_agreement.pdf. This decision means that lawyers need to review their existing agreements to see how this change will effect the rights of their clients. They also need to be much more careful about drafting patent agreements. 

Another troubling aspect of the Transcore decision is its finding the covenant not to sue applied to a patent not yet issued at the time of the settlement on the basis of the theory of “legal estoppel.”